Nationwide Mortgage Licensing System (NMLS) Practice Exam

What type of insurance is typically required for conventional loans when the down payment is less than 20%?

1. Title insurance

2. Homeowner's insurance

3. Private Mortgage Insurance

4. Flood insurance

The correct answer is: Private Mortgage Insurance

The correct answer is Private Mortgage Insurance, often abbreviated as PMI. For conventional loans, when a borrower makes a down payment that is less than 20% of the home's purchase price, lenders typically require PMI to protect themselves in case the borrower defaults on the loan. PMI acts as a safety net for lenders, allowing them to mitigate their risk while enabling borrowers to secure financing with a lower down payment. This requirement is based on the understanding that a smaller down payment can increase the risk for lenders, as there is less equity in the home should the borrower encounter financial difficulties and fail to repay the loan. By requiring PMI, lenders can provide loans with less stringent down payment requirements, which can ultimately help borrowers who may not have enough savings to reach the 20% threshold. Other types of insurance mentioned serve different purposes. Title insurance protects against issues with the property's title, homeowner’s insurance covers damage to the home and personal property, and flood insurance provides protection against flooding, which may or may not be required depending on the property's location. However, none of these specifically address the risk associated with low down payments on conventional loans like Private Mortgage Insurance does.